Opendoor (OPEN, Financial), the real estate startup that promised to revolutionize the industry by allowing homeowners to sell their homes quickly and easily, is facing an uncertain future. Declining real estate appreciation and the very real possibility of depreciating real estate values, coupled with raising interest rates and a slowing sales market, makes the company’s core business model look like a thing of the past in my view.
About the company
Opendoor is a technology-enabled real estate company founded in 2014 by Eric Wu, JD Ross and Keith Rabois. The company's mission is to make buying and selling a home as easy as booking a hotel or buying a plane ticket. Opendoor operates as an I-buyer, which means that it uses technology to make instant offers on homes and allows homeowners to sell their homes quickly without going through the traditional process of listing the property with a real estate agent. The company was initially founded in Phoenix, Arizona and expanded to other markets in the United States such as Las Vegas, Dallas and Atlanta. In 2018, the company raised $325 million in a series D round of funding, bringing the company's valuation to over $2 billion. In 2020, the company was brought public via a SPAC investment, and it has grown both revenue and debt significantly since its launch, becoming one of the leading (in terms of sales) players in the I-buyer market in terms of revenue and transactions.
The I-buying model
I-buying, also known as instant buying, is a process where a company uses technology to make an instant offer on a home and purchase it directly from the homeowner. This process is like the traditional practice of home flipping, where an investor purchases a property, makes repairs or renovations and then sells it for a higher price. The main difference between I-buying and traditional home flipping is that I-buying is done quickly and often without the need for any repairs or renovations. Both I-buying and home flipping involve buying a property with the intention of reselling it for a profit, but I-buying is done on a much faster timeline and with the use of technology to make the process more efficient.
It should be noted that most I-buyers add very little value to the property in terms of fixing it up. I have personally toured many homes owned by Opendoor in the Denver market and they could all be characterized as very light flips with new carpet and paint but very little design work or significant capital improvements. In terms of home flipping, I-buyers like Opendoor are not adding much value at all to the real estate inventory they own for resale.
Flipping homes and I-buying are investment strategies that work well when the real estate market is appreciating. When home prices are increasing, investors can purchase properties at a lower price and sell them for a higher price, resulting in a profit. According to the S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, the national average home price appreciated by over 15% from 2018 to 2022. In this period, many markets have seen even higher appreciation rates, making it an attractive time for home flippers and I-buyers to invest. As the real estate market continues to appreciate, these investors can continue to make a profit by purchasing properties at a lower price and reselling them at a higher price. With over 15% nationwide appreciation, it’s no wonder why flippers and I-buyers have saturated the real estate market. It should be nearly impossible to lose money if your homes, your company’s inventory, rise in value by over a percentage point a month. Opendoor’s best quarter in its short corporate history was first quarter of 2022 when the company raked in $5.15 billion in gross revenue with about $28 million in GAAP net earnings.
This banner quarter, if you can call a $28 million profit on over $5 billion in sales a good quarter, was precipitated by an absolute frenzy in the real estate market. Bidding wars and paying over listing prices on real estate where commonplace nationwide in America as mortgage interest rates hovered near lows never seen in the last 100 years of American financial history and the housing inventory was near record lows.
When the bubble bursts
In the future, I think the early part of 2022 will go down in history as one of the frothiest real estate markets of all time. Unfortunately, like tulips in 17th century Holland, the party can’t go on forever. One of the earliest market bubbles in recorded history, the Dutch tulip mania was a period of frenzied buying and selling of tulip bulbs in Holland, driven by speculation and hype, which ultimately resulted in a market crash. The rise in interest rates in early 2022 may have had a similar effect on the real estate market, causing prices to later cool down and potentially leading to a market correction.
Moving forward from the banner first quarter numbers of 2022 for Opendoor, the projections for the real estate market appreciation over the next two to three years are mixed, as rising interest rates could have a significant impact on the market. The relationship between interest rates on mortgages and the inventory and valuations of residential real estate can be complex. Generally, when interest rates on mortgages rise, it can make it more expensive for potential buyers to obtain a mortgage, which can lead to a decrease in demand for housing. This can result in an increase in the inventory of available homes for sale, as sellers may find it harder to find buyers for their properties. As a result, home prices may decrease or appreciate at a slower rate.
In the second and third quarters of 2022, Opendoor reverted to its losing trend achieved every quarter since the IPO in 2020. In the third quarter of 2022 the company announced its biggest quarterly loss of $928 million on $3.361 billion in gross revenue. The huge loss was partially attributed to a $573 “inventory valuation adjustment.” This adjustment is accounting parlance that represents the company attesting that it overpaid for inventory by over half a billion dollars. This inventory impairment furthered the fact that, on paper, the company lost a whopping $928 million.
To add insult to injury, Opendoor’s carrying cost on the debt its business model relies on will rise as home appreciation continues to slow. Both facts are precipitated by our current rising interest rate environment. The company reported over $8 billion in debt at the end of the third quarter of 2022 and a interest expense of $115 million during the same quarter, a jump in quarterly interest expense of 267% from that of a year ago.
Opendoor’s projections for the fourth quarter are equally bleak. The company is projecting gross revenue to be in the $2.3 to 2.5 billion range, a decrease of over 30% from the same quarter in 2021. The company is also projecting an adjusted Ebitda loss of somewhere between $335 and $355 million. It should be noted that the company currently has $1.5 billion in cash and liquid assets and $11.8 billion in lending capacity as of the end of the third quarter of 2022. However, with rates rising and home prices staying flat, with the real possibility of declining, any lender in their right mind would begin to look at Opendoor’s continual losses and wonder how prudent extending more debt will be in the future.
A more likely scenario as the company continues to drain its cash reserves month after month is that lenders will start to call back their money and forgo new lines of credit. A kiss of death for Opendoor would be if the company’s lenders and investors simply turn off the spigot of money altogether as the likelihood of discounted repayment heightens with each inevitable quarterly loss and continual decrease in its cash position. At the projected loss rate that Opendoor itself is predicting for next quarter, the company will run out of cash within a year and must rely solely on any bank that still believes in its business model.
The equity markets have not been kind over the last year to Opendoor. As of this writing, the company has shed 300% of its market cap in the last 12 months. Investors who can see the writing on the wall are heading for the exits as the losses mount quarter after quarter. As it pen this, the company's market cap sits at around $1.27 billion with the stock trading just over $2 per share. This meteoric drop represents a loss of almost 1,400% since the stock's high water mark in February of 2021 when shares traded for $28 per share.
Conclusion
In conclusion, Opendoor's high debt load and the cost of servicing this debt, along with the company's inability to generate a profit, historical losses and a downturn in the real estate market, all point to the company’s imminent insolvency within the next couple years. Unless the company rapidly changes its business model, or both the housing market appreciation and debt market affordability resume, I don’t see any positive outlook for the company moving forward. The company barely managed to eke out any profits when the real estate market was booming. The I-buying model will be long forgotten if the real estate resale market is flat or goes down. The story of Opendoor is a cautionary tale for any company that relies on debt to finance a rapidly appreciating asset class and the importance of having a sustainable business model for all market conditions.
